ECB cuts rates to ward off eurozone deflation threat
The European Central Bank cut interest rates to new record lows on Thursday, unexpectedly lowering borrowing costs to try to lift inflation from rock-bottom levels and support the stagnating eurozone economy.
Frankfurt: The European Central Bank cut interest rates to a fresh record low on Thursday and launched a new scheme to push money into the flagging euro zone economy, surprising markets and leaving open the option of more to come.
In a series of measures highlighting growing concern about the currency bloc`s health, the ECB cut its main refinancing rate to 0.05 percent from 0.15 percent and drove the overnight deposit rate deeper into negative territory, now charging banks 0.20 percent to park funds with the central bank.
The International Monetary Fund, which has pressed the ECB to do more to buoy the euro zone, welcomed the measures. The euro zone flatlined in the second quarter of the year and the Ukraine crisis is now weighing heavily on business confidence.
"QE was discussed," ECB President Mario Draghi said of the possibility of quantitative easing (QE) - essentially printing money to buy assets.
"Some of our Governing Council members were in favour of doing more than I`ve just presented, and some were in favour of doing less. So our proposal strikes the mid-road," he said.
New ECB economic forecasts foresee slower growth this year, of just 0.9 percent, picking up to 1.6 percent in 2015.
The forecast for inflation, now running at just 0.3 percent, was cut to 0.6 percent, rising to 1.1 percent in 2015, still way below the ECB`s target of close to but below 2.0 percent.
Draghi said if inflation looked like staying too low for too long, the ECB Governing Council was unanimous in its commitment to using other "unconventional instruments" - a phrase taken as code for printing money as the U.S. Federal Reserve and Bank of England have done.
Draghi dropped previous wording that inflation risks were "broadly balanced", instead vowing to "closely monitor" risks to the outlook for price developments - a shift that reflects the ECB`s increased concern about the inflation outlook.
Draghi announced plans for an asset-backed securities (ABS) and covered bond purchase programme to help ease credit conditions in the bloc. Sources told Reuters it could amount to 500 billion euros ($650 billion) over three years.
IMF Managing Director Christine Lagarde said: "We strongly welcome the measures taken by the ECB, which will help to counteract the dangers posed by an extended period of low inflation."
Asset-backed securities are created by banks pooling mortgages and corporate, auto or credit card loans and selling them to insurers, pension funds or now even the ECB.
Covered bonds are similar instruments but the underlying assets, such as apartment blocks, are ringfenced so if the bank goes bust, the assets are still there. That makes them safer than ABS where the underlying loans are not ringfenced.
"At the margin, (the cuts) may have some small positive effect on bank lending and activity and perhaps give the euro another downward nudge," said Jonathan Loynes, chief European economist at Capital Economics.
"But these moves are no substitute for the much more powerful policy action which looks increasingly necessary to prevent a renewed recession."
QE OR NOT QE
For investors and markets, the only gambit that will make a big difference is a large-scale U.S.-style asset purchase, or QE, programme that buys government debt with new money.
Marcel Fratzscher, president of Germany`s DIW economic institute, said the unexpected measures showed the ECB had taken a more pessimistic view about growth and price developments than previously.
"I expect today`s measures will not be the last," he said.
"The ECB has other options, and these include buying sovereign bonds and private bonds. I see the probability as very high that the ECB will implement the purchase of sovereign and private bonds in the coming months."
Draghi ramped up expectations when, departing from the text of a speech, he told the Jackson Hole central bankers` conference on Aug. 22 that markets had indicated inflation expectations showed "significant declines" in August.
Then, he said the ECB`s Governing Council would, within its mandate, "use all the available instruments" to deliver price stability over the medium term.
Though other central banks have printed money in vast amounts, some members of the ECB`s 24-member policymaking council are resistant. An ECB source told Reuters last week that "the barrier to QE is still very high".
What is more, the ECB will want to see the impact of a four-year loan offer to banks, announced in June but only launching later this month, before taking the ultimate step.
The interest rate cut will make the upcoming loan offer, or TLTRO, more attractive as banks can now get the funds for less. But with lending still impaired, the wider impact is uncertain.
Draghi also expanded on his call in Jackson Hole for governments to use fiscal policy - more government spending - and economic reforms to support the euro zone economy.
He said euro zone countries should use existing flexibility within its debt rules, rather than break them, in order to help pursue structural economic reforms.
"This is Draghi saying ... to European leaders … that we’ve thrown the kitchen sink at the problem," said Jacob Kirkegaard, an economist with Washington think tank, the Peterson Institute.
"We are at the end of the road. The ball is in your court. Now you have to deliver on your part to restart growth in the euro zone."